Net-Lease Booms as Investors Seek Yield
Posted on March 7, 2020
Net-lease deals, commonly called triple-net leases, offer several advantages for landlords and investors in commercial real estate. By shifting the burden of rent, utilities, property taxes, building insurance, and maintenance expenses to the tenant, they serve to mitigate risk, keep expenses predictable, and decrease management requirements. Combined with the fact that they are generally longer-term contracts, they also smooth out issues with vacancies. Note that the benefits don’t just accrue to the landlords: In exchange for the longer terms, the tenants generally have 1) lower initial payments than they would in a comparable gross lease and 2) rent escalators that are predictable and lower than anticipated market rises.
In the wake of positive growth in 2018, last year saw even more significant increases in net-lease deals nationally and here in the Greater Phoenix market—and 2020 is looking to continue the trend. According to AZ Big Media, national net-lease investment volume year to date through Q3 2019 climbed 24% and represented 14.6% of total commercial real estate investment. Meanwhile, Phoenix ranked in the top five U.S. markets for net-lease investment in Q3 2019 with total volume of $863 million—up nearly 40% year over year. For the year ending Q3 2019, net-lease investment in Phoenix totaled $1.77 billion—up nearly 9% year over year.
Looking Behind the Numbers
What’s responsible for the surge? The bottom line is investors’ hunt for yield when other assets are too pricey, as well as the ability to mitigate risk with longer-term deals. The Phoenix market, in particular, is benefiting from its status as a secondary market, which offers comparatively lower prices, greater upside potential for appreciation, and higher cap rates than the major metros. As noted in the December issue of The Real State, Arizona is aggressively leveraging its advantages against California, with an overall economy and pro-business environment that make it an enticing proposition compared to our more expensive, higher-tax neighbor. That has had a dual effect: Capital from Golden State investors has flowed into the desert to seek better opportunities, and corporate entities and subsidiaries have migrated to find affordable industrial, office, and retail space. In the case of the latter, a good example of a high-profile net-lease deal is Palo Alto-based Tesla’s redeveloped site in the Scottsdale Airpark, its largest-ever investment in Arizona. As we always caution, we don’t have a crystal ball on how trends will play out. Interest rates will play a key role going forward, given how much last year’s cuts positively impacted markets, so that’s something to keep an eye on. At the moment, at least, the buyer-demand-fueled strength in net-lease deals appears to be durable.